I'm assuming they're not selling your cookies, that it's a promotional give away? Maybe they just admire and respect your work and want to support local small business. If that's the case, they're not expecting you to discount.
If you want to build a relationship with them, think ahead to the next time and what you're setting yourself up for. If you're thinking you'll get a lot of exposure so it's worth discounting for the advertising, we've all been there too. How much business will you lose because you have to pass on baby and wedding showers and birthday parties full of your specific target customers because you're busy making free cookies for people who would never, ever pay $3 for a cookie?
It's a wonderful compliment to have been invited to bid and regardless of what you decide or whether you win the job, you can pat yourself on the back and enjoy the validation .